Sunday, January 14, 2018

Using retirement funds pre-retirement

It is common wisdom among estate planners and commenters on financial matters that people between the age of 60 and 70 should not touch their retirement accounts until they are required to do so, and that those who have reached the point at which they must take required distributions (around age 71) should take only the required minimum distributions (RMDs). While this is good thinking for many people, it will not work for everyone. 

The common recommendation no doubt arises from the assumption that most clients have a sizable retirement account and a sizable investment account comprised of non-retirement assets. The recommendation is based on the fact that non-retirement funds consist of money on which tax has already been paid, and thus using that money will not result in the recognition of income and the imposition of additional tax based on that income. 

But a client who has a very large retirement account and whose other assets are modest may benefit from a bit more liberal thinking about the use of the retirement funds. 

Let us do a bit of calculating for a moment. Let’s begin by assuming a client who 60 and who has exactly $100,000 in retirement funds. We know that 
  • His RMDs will begin in about 10 years. 
  • His accounts are likely to grow to about $138,000 in that time, assuming no additional contributions are made. 
  • His RMD for the first year, often his age 71 year, will be $5,223. 
A $5,000 annual distribution is of course not much. 

These calculations do “scale” perfectly, though. If we change one assumption, considering a retirement account with a current value of $1 million, it will change the following parameters. 
  • His accounts are likely to grow to about $1,380,000 in that time, assuming no additional contributions are made. 
  • His RMD for the first year, his age 71 year, will be $52,230. 
Now we are talking about a significant required minimum distribution. 

Let’s say that our client decides that he wishes to use the money to enhance his quality of life during the next ten years. Each year, he wants to use $7,500 of his accounts (probably netting about $6,000 after taxes) to do some traveling with his wife. What is the result? 

When he reaches age 71, he finds that 
  • His total retirement account is $1.3 million, or about $80,000 less than it would have been if he had not touched the money. 
  • His initial RMD is $49,000, or about $3,200 less than it would have otherwise been. Each successive RMD is also moderately smaller than it otherwise would have been. 
The differences, in all honesty, are not that great. And there is a real-life factor that seems to elude many who comment in this field. In general, our client is likely to be much better able to travel and get around in his 60s than he will in his 70s. The ability to use his money to travel and in general to enhance the lives of both spouses is likely to be greater in their 60s. In general, the money will be more useful to them in those years than it will be when they are 75, 80 or 85 years old. 

Update 12-7-18 - A user at Quora posted this in response to a question: 

I took my pension at 60 and get less than I would have if I had waited until I was 65. However, I got to enjoy retirement between 60 and 65 when my health was good and I could do pretty much anything I wanted to.
Retirement is much less enjoyable when your health is failing. Your eyesight goes so you can’t read or drive any more. Your joints start to ache so sports are less enjoyable. Out of country health insurance costs a lot more so travel is more expensive.
I personally recommend retiring as soon as you can and do as much as you can while you have your health. Living in retirement is a lot less expensive than most people think. I’m very glad I retired when I did.